Credit card spending is back with a vengeance in Canada.
For consumers with a credit card, average monthly credit card spend was almost $2,447 in the third quarter of 2022, according to Equifax Canada’s most recent consumer trends and insights report. That’s up by 17.3% when compared to the third quarter of 2021 and up 21.8% in comparison to the third quarter of 2019 (pre-pandemic).
A personal loan is a way to borrow a lump sum of money at a lower interest rate than credit cards, but before you get a personal loan, it’s essential to have a repayment plan.
These personal loan repayment do’s and don’ts can help you understand the variables that affect your monthly payment amount as well as the total cost, so you can choose the best loan (and lender) for your needs.
Personal Loan Repayment: Do’s
1. Shop around for competitive rates
Personal loan interest rates aren’t just based on the Bank of Canada policy rate. Other factors include the bank’s lending rate, loan amount, term, and their evaluation of your personal criteria (like income and credit score).
All together this determines the interest rate and loan repayment terms you are offered, which will vary from lender to lender.
2. Consider the total cost of borrowing
Don’t be lured in by the offer of lower monthly payments over a longer term; they often come at a cost, and that cost is more interest paid in the long-run (which works in the bank’s favour, not yours).
For example, if you are offered the following three options for a $2,000 loan, multiplying the monthly payment amount by the total number of payments reveals your actual cost of borrowing:
- $185/month for 12 months = Total cost: $2,220
- $75/month for 36 months = Total cost: $2,700
- $53/month for 60 months = Total cost: $3,180
3. Pay attention to fees
Interest is not the only cost to calculate when you get a personal loan; some lenders may charge administration or set-up fees (also called origination fees), yearly maintenance fees (mostly for longer term loans), late payment fees, non-sufficient funds fees (NSF), and even prepayment fees.
4. Automate your payments, if you can
Setting up automatic loan payments (also known as pre-authorized debits) will ensure your payments are always made on time, which may have a positive impact on your credit score and protect you from costly late or missed payment penalty fees.
Personal Loan Repayment: Don’ts
5. Borrow more than you need
Banks make money by charging interest on loans, so they may offer you a higher personal loan amount than you apply for. Unless you actually need the extra money, it’s best not to take it. (Remember: even if they tell you the monthly payment will be the same, the term will be longer which means more money out of your pocket).
6. Make extra payments before knowing the fees
If you make extra payments, you’ll reduce your personal loan principal faster than planned, and the total amount of interest you’ll pay along with it. Lenders may be more interested in you finishing your full loan term because they’ll make more money that way. To compensate, they may charge a fee for paying off the loan early.
7. Be late or miss a payment
The only thing worse than a late personal loan payment is a missed payment. Failing to pay on time will not only entail extra fees, but may have a negative effect on your credit score, could result in the lender demanding immediate payment of the entire loan amount, and, if not resolved quickly, may lead to legal action.
If you’re in danger of missing a payment, contact your lender right away. And if you’re prone to paying late or missing payments through forgetfulness, set up an automatic payment plan so loan payments can be deducted automatically from your bank account.
8. Cash in RRSPs to make loan payments
Withdrawing money from your RRSP has multiple costs, the ultimate of which is the compound growth of your retirement savings. But you will also pay income tax on the amount withdrawn. If you absolutely must tap into savings to make a loan payment, withdrawing from your TFSA may have lesser consequences.
Personal loans are funded quickly and feature lower interest rates than credit cards, but may be too restrictive for major home improvement projects.